Cadence Capital Limited (CDM) Earnings Call Transcript & Summary

Ladies and gentlemen, welcome to the March quarterly update for Cadence Capital Limited. As you can see from the year-to-date performance, we've outperformed the Ordinaries Accumulation Index. And over the past 2 years, the fund is up 29.9% per annum, outperforming the All Ordinary Accumulation Index by 8.4% per annum. Year-to-date, our top contributors have been TMC The Metals Group, Whitehaven Coal, New Hope Coal, Upstart, DigitalOcean, Johns Lyng Group and Champion Iron. Our biggest detractors for the period have been Resimac, Bed Bath & Beyond and Nitro software. All of the teams see the Metals Group has now been sold. And as we have previously indicated, CDM has realized a substantial profit on this investment. Turning now to the half year dividend. We're just once again confirming that the $0.04 interim dividend has now been paid, bringing our total dividends paid to $1.132. And when you include the franking on those dividends, EUR 1.607 of dividends with franking have been paid to date. That $0.04 fully franked dividend will be paid on the 14th of April 2022 and is a 100% increase on the previous half year dividend. This equates to an annualized yield of 8.2% fully franked or 11.7% gross up for that franking based on the share price at the time of this announcement of $0.98. Importantly, this equates to around a 7% dividend yield based on pre-tax NTA as CDM shares are still trading at a discount to NTA, although not as large a discount as they were. The company is well positioned to pay an increased dividend. After paying this dividend, the company has $0.30 per share of profit reserves to pay future dividends. The DRP program was operational for the half year dividend, and we had good participation from our shareholders. The next slide is the pre and post-tax NTA. You can see on the 13th of May 2022, our pre-tax NTA was $1.04. Our post-tax NTA at $1.15, and our share price was trading at $0.95. The NTA discount has significantly improved from the nearly 40% discount we reached at the panic lows in March 2020 relating to the COVID pandemic. We are now trading at a 9% discount to pre-tax NTA and a 17% discount to post tax NTA. Obviously, there's an opportunity to purchase CDM shares at a discount and receive a high fully franked dividend yield at the moment. Board and management continue to be the largest shareholders and continue to add to their position in CDM. Importantly, you can see on this portfolio composition slide, the fund continues to be very liquid and to hold positions that can be easily acquired or disposed of. And approximately 85% of the fund's gross exposures in companies with a greater than $1 billion market capitalization and the liquidity of the portfolio has obviously improved significantly over the past few years. And as we keep highlighted, this has been an important component of managing risk within the portfolio. Currently, more than 95% of the portfolio is able to be liquidated within 1 week and over 98% of the portfolio within 1 month. Adding to that risk mitigation is the following slide, the top 20 shareholdings as of the 30th of April 2022, and you can see a well-diversified portfolio and a portfolio that looks very different to what the portfolio looked like 6 months ago. And I keep urging our shareholders at the moment to refer back to the last webcast that we did and to the prior webcast to that to see how clearly the fund has been able to migrate into new sectors, both domestically and offshore and that this has been possible because of those high liquidity levels. Turning now to the slide involving cash and gross and net exposure. You can see the fund in the slide moving in and out of cash. Our investment process moves the fund into and out of cash as the share price of their underlying investments in the fund move up and down, respectively. And your shareholding and exposure to equity markets has reduced as CDM moves into cash. So you can see, for example, right now that we have indeed moved from a period of being almost 80% invested to now around 60% invested. We were once again more invested, let's say, 70% and once again holding 40% cash. An actual fact right now, as we're speaking, we hold around 45% cash and equivalents. So we're constantly through our process of scaling into and harder positions moving into and out of cash. And so that is, again, a very important risk mitigation strategy for the business and also means at the moment that there's only a portion of your portfolio that's exposed to the equities markets at the moment. I'd now like to turn to Charlie and Jackson to take you through some of the current investment themes, many of which we have been talking about in the last webcast, but also to take you through specific stock examples, as stock examples and specific stock selection is becoming an important component in alpha generation at the moment.

Thanks, Karl. My name is Charlie Gray, Portfolio Manager here at Cadence Asset Management. Today, I'll touch on a couple of investment themes we're seeing in the market, and then I'll touch on a couple of stocks and hand to Jackson, who's going to touch on a couple more stock-specific investments in the firm. So in terms of the theme of higher interest rates and inflation, that's certainly built momentum through this year, which you would have seen through the media. We've seen U.S. bond yields reach 3%, which is quite a meaningful level, the highest since 2018, and we've seen central banks continue to increase rates. The [ Feds ] trying to get to 2% by July. It looks and is starting to actually wind back or reduce the balance sheet for the first time in many years from next month from June, which will be quite important in terms of liquidity. The major changes in sector trends that we outlined in 2021 have also continued. This is resources and energy strength. Certainly, energy is the leader here more recently. And technology and small cap weakness developed certainly in December and through the first half of this year, it's really picked up momentum. More recently, we've seen other sectors also roll over and start to trend lower, whether it's mega cap technology, which had been holding in quite well, semiconductors, financials, consumers, consumer staples, consumer discretionary, there's a number of other sectors that have started to perform poorly as well. And as a key point here that the performance of the broad market indices has started to only catch up to the underlying weakness that we've been seeing building over the past 6 to 12 months just recently. So now that really, it's been the mega caps that have started finally to correct. You see that the NASDAQ is now down 27% and the S&P 500 is down 17%. But for context, in the NASDAQ already 50% of the stocks within that index are really down 50% and nearly 1/3 of stocks in that index are actually down 75% now. So it's been quite a significant correction. And that is obviously where a lot of the technology stocks were with the highest valuations. They are the most impacted by this change in conditions and move to higher interest rates. So price earnings or PE compression, it's becoming an increasing feature. Investors are looking at higher interest rates. They're looking at a more challenging outlook for earnings growth in many businesses. So they're putting -- putting stocks on lower valuations. And for the overall market, now we see the forward price earnings ratio for the S&P 500. That's the 500 biggest companies in America. That's now back to 17x. This is around the 10-year average. So in COVID, in -- when they went to 0 interest rates, you got up to around 24x. And it's been down to 13, 14x in recent years when there's been a slowdown. So turning to the next slide. Here we are investing in this environment to this inflationary and increasing interest rate situation. You would have seen the significant changes in the portfolio over the past 6 months. And particularly in the top 20 years, you could see every month the names there versus 3 months ago versus 6 months ago, there's been 6 changes there. Spent a lot of stocks that we've exited. And in terms of something that's grown in the portfolio is really energy. This was a meaningful part of the portfolio, but now it's over 40%. It's one of the last strong sector up trends we see globally. We believe that there's a strong fundamental basis for this that we'll discuss in the next slide. Capital preservation has been a focus for us. We've been on average, 30% cash over the past 6 months. Currently, we're around 40% cash, and this is also a reflection of the amount of opportunities that we're finding that are meeting both the fundamental and technical criteria. So we need something that's in an uptrend and that has strong fundamentals, and there's just isn't as many as they were 6 months ago. There's also a higher focus for us on core positions. We're seeing that the market's now rewarding lower valuations, rewarding our free cash flow again in this changing environment and valuations matter again. So we're also watching for changes in trend and an improvement in breadth. What we would like to see is rather than more sectors join in the down trend the other way, whereas the indexes might continue to fall, if we could see more participation below the surface and healthier price action, that would be a step in the right direction. Bottom-up fundamental research is also playing an important role for us now, identifying special situations where we can find stocks where their price performance isn't going to be tied to general economic conditions or the overall market cycle. And Jackson has got a couple of really good examples for that, that he'll touch on that amount. There's been increased shorting activity in the fund, certainly no longer a rising tide environment. So there's definitely more opportunities that we find on the short side to generate some good after there. Maintaining high levels of liquidity, that's also key in this period, and this allows us to respond quickly to any changes in conditions. If there was any change to the outlook, this is something that Karl touched on. The portfolio is very, very liquid, will allow us to be able to move very quickly in or out as required. Okay. So turning to the next slide. In terms of specific stocks. We're really looking at the energy sector at the moment. And so in terms of this commodity book market that we spoke about in the December quarter is really supply disruption-driven bull market. We've seen a bit of a divergence in the last couple of months of where -- which stock is performing. In the mining sector or the sort of base metals, this is corrected, particularly in the wake of their quarterly results, which showed significant increases to cost and a lot of issues around our staffing. And there's also been some questions from investors over the ultimate demand outlook for some of these metals in an economic slowdown and also given that China is going through COVID lockdowns. On the other hand, the energy sectors continue to perform. We see there the demand is less discretionary. It's actually essential for a lot of these commodities, the energy commodities, and the supply situation there remains heavily disrupted with really Europe doubling down and putting restrictions and sanctions on Russia through -- over the last couple of months, which has just made the situation more stressed in terms of countries and businesses really fighting for what's left over in the global marketplace in coal, in oil and gas. The coal sector, in particular, is a big weighting in the portfolio. So I thought we'd touch on that. Despite the recent strong gains that we've seen there, it remains very cheap at spot prices. I've put in some of the spot valuations based on the current coal price, and you can see the massive free cash flow yields. So while pricing will eventually moderate, we believe it's going to take longer than many expect. The last webcast, we talked to some of the restrictions, whether it's political pressure, ESG policies that are in place now, a lot of the banks are pulled out of the financing. There just isn't a project and supply that's going to come online to offset this. And on the other hand, with Russia, of course, it's an unknown, but it seems to be reducing probability that there's going to be a near-term resolution there in terms of the sanctions. So we believe that in the meantime, these stocks, there's a significant capital return opportunity. For Coronado, they've just announced 17 special dividend out of the cycle after already paying $0.13 for the first half. So you're already at 14% before you get to the final result of the final dividend. And you hope potentially it's going to pay the most of the lot, $0.30 for the first half. It's already announced, which was unpaid, which was 10% fully franked. Our research shows that the second half dividend could be over $1 a share, fully franked, using the same payout methodology, looking at current coal prices and the cost base. So we don't know exactly what it's going to be, but the management and Board there have been very clear that their strategy is to return all of the excess capital to shareholders, and they've got still a massive tracking credit balance that they got with the sale of new Saraji in 2008 to BHP. They've still got over $500 million in excess frank credits there. So they can pay significant fully franked dividends back to shareholders over the next little while, which we think is very compelling. Okay. So hopefully, that gives you a bit of a flavor for what we believe is still compelling and what's still working from a technical and fundamental perspective in the market. I'll now hand to Jackson to touch on a couple more of those stock-specific situations.

Hi. My name is Jackson Aldridge, Portfolio Manager at Cadence Capital. I'll now talk about 2 stocks. The first being AGL, which is a core position and a long for us. We actually were short this stock over the last kind of 18, 24 months. It was one of our most profitable short positions over the last couple of years. So we're quite familiar with the business and know it intimately well and covered our stock around about $6. And when it got to that level, we took another look at the business and the assets there and the CapEx that's been spent and thought that if wholesale electricity pricing were to turn around, the business is potentially massively undervalued by the market, and they just needed a few things to go right. So what I believe has changed, I think there's 3 things that have changed in the near term. It's been very publicized. The first being Mike Cannon-Brookes and Brookfield at the time, made a bid at $7.50. We thought that was really opportunistic. I think it was a 7% premium to last at the time. And then they followed up with an $8.25 bid only to be rejected by the Board, not even a hint of due diligence or potential agreement or whatnot, strictly from the management saying it's massively undervalued. And we believe that too, looking at the $4.5 billion of CapEx that AGL has spent in the push to renewables. The NTA is roughly $3 billion. And we believe the 2 businesses combined whether demerged or not that they'll spit-off roughly $1 billion in cash flow per annum in a normalized wholesale electricity environment. So we think that the bid has been very opportunistic and continues to be. There's a demerger vote coming up on June 15, and Mike Cannon-Brookes has been very, very public in China to ruffle some feathers. What his ultimate plan is, I'm not sure. But what I do know is, I think, by his actions, he's recently taken an 11.5% stake, which is roughly $650 million PA that is taken through his Grok Ventures and an $8.25 bid, I think he understands his assets are undervalued. So what I think is interesting was the consortium originally involved Brookfield and Brookfield have form in this space. They've bought 2 electricity-generation-related businesses in the past with AST selling for roughly $10 billion or 16x EBITDA. And then in TeleHub for $1 billion or 17.5x EBITDA. So this AGL Australia business, the retailing business would potentially -- you could argue that that's kind of the final piece of the puzzle for Brookfield to own a large portion of the electricity generation value chain. And roughly, the business is trading at 6x EBITDA. So there's a mismatch in valuation. There's a discrepancy there that we already -- that we think is huge. And given the cost of capital for private equity, we believe that they could significantly sweat the assets here inside the HL business. So I don't think $825 is the last move there. I guess the second point that's really changed, there's a demerger happening or not. But regardless, that it's basically we feel in the market saying, and Mike Cannon-Brookes are saying that the value is greater than the -- the value of the assets is much greater than the share price right now. As I mentioned before, $4.5 billion of CapEx has been spent, that AGL Australia business is a highly profitable, highly lucrative business in the sense that there's a huge customer base that it would make sense for someone or it'd be very synergistic for someone, i.e., potentially a Telstra or someone to plug in that would get into the electricity market very quickly and would provide a number of synergies. So we think that business is due to re-rate and as I mentioned before, the combined entity is going to potentially generate over $1 billion of free cash flow and $3 billion of NTA. So given where the current share price is, it's very cheap. And I guess the last point that's really changed and probably more importantly, to the fundamentals of the business is the wholesale electricity pricing is very, very strong. It's up 67% in the first quarter of 2022 to $87 a megawatt. And then since then, our data is suggesting that it sincerely up to $150 a megawatt. So wholesale pricing is up very, very strong. Legislation doesn't allow retailers to pass through a large chunk of that until July 1. So we won't see the huge benefit now. But in the coming years, I think you'll see the margin uplift for retailers. And then I think what the market is really missing with this business is AGL has actually hedged out their coal exposure. We all know what's happened with the coal price. AGL's hedged out their coal exposure through FY '28. So our math suggests it's roughly -- it could be $250 million, $300 million per annum EBITDA tailwind on a business that does -- the business that does $1.5 billion of EBITDA. So on our numbers, it suggests that the business could be on 5x PE at 15%, 16%, 17% operating cash flow yield. It's a very, very cheap asset at the moment, which I think is under-earning. The second stock that I'd like to talk about is AMP Capital. And I know, again, like AGL, it's been -- it's detonated from a share price perspective. But it's a very similar pitch. We believe as the assets are starting to become more worth nearly the whole share price. And I'll walk it through in a sense that the new CEO has come in, and she's made it very, very clear that there's a chopping up with the business, a simplification and getting rid of a lot of the problem and simplifying the A&P business. So what we think there and from what management has told us through recent divestments, the [ Coleman's ] divestment to Dexus, existing capital, seed capital that the business has existing liquidity balance that the company has given the market. That totals about $1.3 billion that -- of excess capital available in the next couple of months. And then over the next 12 months, there's a number of management fees, earn-outs rights related to the real estate divisions and sales and carried interest from infrastructure equity. We believe this totals approximately another $1 billion. The core business, which is AMP Australia, AMP Wealth -- sorry, AMP Bank, AMP Wealth, AMP New Zealand and a couple of Asian AMP equity stakes. That business will spit off roughly $200 million of free cash flow this year. So if you total those 3 up, it's roughly $2.5 billion of excess liquidity on a market cap of roughly $3.5 billion right now. What the management has said to the market is they'll pay between $200 million and $400 million of debt. So if we take the midpoint of that, roughly $300 million, we kind of get to $2.2 billion of excess liquidity that the company has said that will go into capital management. So that's roughly $0.68, $0.70 a share on a $1.15 share price that will be given back to shareholders over the next kind of 6, 12, 18 months. So then what we need to look at is the remaining stub of what's left over, as I mentioned, what is left over. The bank is growing twice system growth. So it's going twice the other -- twice the rate of the other banks. And then the wealth business has had some issues. The New Zealand business is pretty solid. And then there's some stakes in A&P businesses kind of minority shareholdings. So that business is on track to do roughly $250 million to $270 million of NPAT. So backing out the excess liquidity or the cash and the market cap currently, the AMP Bank or this stub business is on just over 4x PE. Competitors are trading at 14, 15, 16x PE. So we think there's a huge re-rate of the stub to come once shareholders start to realize the sum of the parts here and what's actually happening and what's going to be left over. And then I guess the final piece to the puzzle is once there's a capital distribution or capital management will either be a buyback or a distribution, we feel it will be a combination of the both. So once as a distribution, the market cap of AMP will come in below what an ASX 100 stock requires. So it will come out of the ASX 100. And what that means is a lot of small-cap fund managers can't own or don't own 100 ASX 100 stocks, but they will own 200 stocks. So there's going to be a lot of force buyers or funds who are going to have to market weight or overweight or have some weighting to A&P. So there's a huge wave of buying that will come into the stock as well as the re-rate that we think is going to happen. So those are the 2 stocks I wanted to talk about. I'll now pass it over to Karl to finish up the presentation.

Thanks, Charlie and Jackson. Turning now to the outlook slide. Will global financial markets have continued to trend lower in recent months, and this is a trend that started some time ago and looks simply to be continuing, which is an important observation. Australia has outperformed its international peers. We have higher weightings to resources and energy and defensive sectors and less weightings in technology and what we call the growth stocks. Interest rates and inflation trends globally remain the key driver of financial markets. The RBA lifted interest rates in May and has signaled further increases. Similarly, central banks around the world are lifting interest rates. We shouldn't underestimate how important this change in trend is. We have had falling interest rates in Australia for 30 years now, and we're now seeing a change in that trend and rising interest rates. And whereas a year ago, it not -- may not have been universally accepted that interest rates were going up. I think it is more or less universally accepted now that interest rates are, in fact, going up. Obviously, the outlook for consumer demand is becoming more challenging with higher costs for both businesses and households. The trends in the resource sector have diverged with energy remaining the clear leader in coal, gas, uranium and nuclear performing well. And some of those base metal stocks, some of them performing well, some performing not so well. And clearly, a large sway of the rest of the market actually performing poorly. So this -- the trend in resources and energy that emerged almost a year ago continues. Obviously, finding opportunities in stock-specific situations is not tied to general economic conditions, and that particular stock selection is going to be an important component of alpha generation in this environment and going forward. Maintaining high cash and liquidity levels is also preserving our capital and is an important component of risk management in this environment. And it should not be left unsaid that obviously, an open mandate and the ability to move in and out of cash are important in mitigating risks in these market conditions. Ladies and gentlemen, thanks again for your time, and please do not hesitate to contact us if you'd like to speak with us in person. And obviously, as I always say, to keep up to date with Cadence, please do join our newsletter so that you receive the newsletter and you receive any of our webcast and periodic results. Thank you.